Financial Innovations and the Shaping of Capital Markets

Abstract

Collateralized debt obligations (CDOs), first introduced into the financial markets in 1987, is an application of the securitization technology first applied to the creation of residential mortgage-backed securities. With annual issuance exceeding $100 billion in 1998 CDOs were the fastest growing investment vehicle of the last decade. This article demonstrates that the CDO market has become large enough to dominate the respective underlying collateral markets. It does so by examining three collateral types: high-yield loans, mezzanine mortgage asset-backed securities, and trust preferred debt. The results show that issuance of CDOs backed by these asset types has steadily increased and has lead to an increase in the issuance of the underlying as well as tightening of its spreads.